intercompany transfers of services and noncurrent assets part 1
TRANSCRIPT
Intercompany Transfers
of Services and Noncurrent Assets
(Part 1)
Source:
BAKER CHRISTENSEN COTTLRELLAdvanced Financial Accounting
Ninth Edition
McGRAW HILL INTERNATIONAL EDITION
Learning Objective 1
Understand and explain concepts associated with
transfers of long-term assetsand services.
Summary of GAAP Requirements for Preparing Consolidated StatementsAll intercompany transactions must be eliminated in consolidation.
The full amount of unrealized intercompany profit or gain must be eliminated.
The deferral is shared with NCI shareholders in upstream transactions.
Big Picture: The Consolidated Perspective
From a consolidated viewpoint, the reported amount for a fixed asset cannot change merely because the asset has been moved to a different location within the consolidated group.
Objective: Undo the transfer.
Make it appear as if we only changed the estimated useful life of asset.
P
S
Long-termAsset
Different Asset Types1. Non-depreciable Assets• The transfer of non-depreciable assets is very similar
to the transfer of inventory• Eliminate gains like unrealized gross profit
2. Depreciable Assets• Eliminate the seller’s gain• Adjust transferred asset back to old basis• Adjust depreciation back to what it would have
otherwise been if the original owner had depreciated the asset based on the revised estimate of useful life
Intercompany Transfers of Services
When one company purchases services from a related company, the purchaser typically records an expense and the seller records a revenue. • In the consolidation worksheet, an eliminating
entry would be needed to reduce both revenue (debit) and expense (credit).• Because the revenue and expense are equal and
both are eliminated, income is unaffected by the elimination.• The elimination is still important because
otherwise both revenues and expenses are overstated.
Illustration (Baker et al. 2011, p. 307-309)• Intercompany sale process of land.• A series of transaction: (1) land purchased by Parent company
from an unrelated party, (2) land sold to a subsidiary of Parent Company, and (3) land sold by subsidiary to an unrelated party:• Details of transactions:T1 – purchase by Parent Company from an outsider for $10,000T2 – Sale from Parent Company to Subsidiary for $15,000T3 – Sale from Subsidiary to an outsider for $25,000• The amount of gain reported by each company and by the
consolidated entity in a periods depends on the transactions occur during a period.
Illustration (continue)Case AAll three transactions are completed in the same accounting period.
Case BOnly transaction T1 is completed during the current period.
Parent Company $ 5,000 ($15,000 - $10,000)
Subsidiary Corporation 10,000 (25,000 - $15,000)
Consolidated Entity 15,000 ($25,000 - $10,000)
Parent Company $ 0
Subsidiary Corporation 0
Consolidated Entity 0
Illustration (continue)Case CTransaction T1 and T2 are completed during the current period.
Case DOnly transaction T3 is completed during the current period, T1 and T2 occurred in a prior period.
Parent Company $ 5,000 ($15,000 - $10,000)
Subsidiary Corporation 0
Consolidated Entity 0
Parent Company $ 0
Subsidiary Corporation 10,000 (25,000 - $15,000)
Consolidated Entity 15,000 ($25,000 - $10,000)
Learning Objective 2
Prepare equity-method journal entries and
elimination entries for theconsolidation of a subsidiary following an intercompany
land transfer.
Intercompany Land Transfers• If land is transferred between related companies at book
value – no adjustment or elimination needed in consolidating financial statements.• Because there is no gain or loss, both income and assets
are stated correctly in the consolidation.• Special treatment is needed if land transfer is more or
less then book value – elimination of gain or loss.• There should be no gain or loss from related companies
reported in the consolidated financial statements – until land is sold to other party.
Illustration (p. 310 - 311)Peerless Products Corporation acquires land for $20,000 on January 1, 20X1, and sells the land to its subsidiary, Special Food Incorporated, on July 1, 20X1, for $35,000
Peerless Product
SpecialFoods$20 $35
Jan 1, 20X1 Jul 1, 20X1
Purchase land
Inter-corporate transfer of
land
Consolidated Entity
Illustration (continues)• Peerless records
January 1, 20X1
(1) Land 20,000
Cash 20,000
Record land purchase
July 1, 20X1
(2) Cash 35,000
Land 35,000
Record on Sale of land to Special Food
Illustration (continues)• Special Foods records
• Eliminating entry
July 1, 20X1
(3) Land 35,000
Cash 35,000
Record land purchase
July 1, 20X1
(4) Income from Special Foods 15,000
Investment in Special Food 15,000
Defer gain on intercompany land sale to Special Foods
Gain on Sale of Land 15,000
Land 15,000
Assignment of Unrealized Profit Elimination
Unrealized intercompany gains and losses must be eliminated in consolidating financial statements – regardless parent’s ownership of a subsidiary.
Sale EliminationDownstream (parent to subsidiary) Against controlling interestUpstream (subsidiary to parent) Wholly owned subsidiary Against controlling interest Majority-owned subsidiary Proportionately against controlling
and noncontrolling interests
Illustration
• Purity Company owns 75% of the common stock of Southern Corp.• Purity reports operating income (excluding any
investment income from Southern) of $100,000• Southern reports net income of $60,000, included the
income of selling affiliate is an unrealized gain of $10,000 from the intercompany transfer of asset.
Illustration (continues)
• If the sale is a downstream transfer, all unrealized profit is to be eliminated from the controlling interest.• Consolidated net income (computed and allocated):
Purity’s separate income $100,000
Less: Unrealized intercompany gain on downstream asset sale (10,000)
Purity’s separate realized income $90,000
Southern’s net income 60,000
Consolidated net income $150,000
Income to noncontrolling interest ($60,000 x 0.25) (15,000)
Income to controlling interest $135,000
Illustration (continues)• In the intercompany transfer is from subsidiary to
parent, the unrealized profit on the upstream sale is eliminated proportionately from both the controlling and noncontrolling shareholders.• Consolidated net income (computed and allocated):
Purity’s separate income $100,000
Southern’s net income $60,000
Less: Unrealized intercompany gain on downstream asset sale (10,000)
Southern’s realized net income 50,000
Consolidated net income $150,000
Income to noncontrolling interest ($50,000 x 0.25) (12,500)
Income to controlling interest $137,500
Example 1: 100% Ownership Land Transfer (Non-Depreciable) • On 3/31/X5, Parker Inc. sold land costing $40,000 to its
100% owned subsidiary, Stubben Inc., for $100,000.• In this example, we’ll do consolidation worksheet entries
without adjusting the equity method accounts.• This is the modified equity method. • This is meant to be a conceptual exercise only. (We will
switch to the fully adjusted equity method next.)
Required:1. Prepare the consolidation entry(ies) as of 12/31/X5 and
12/31/X6.2. Prepare the consolidation entry at 12/31/X7, assuming
that Stubben sold the land in 20X7 for $120,000.
Example 1: 100% Ownership Land Transfer (Non-Depreciable)
Parker Stubben$40 $120$100
On 3/31/X5, Parker Inc. sold land costing $40,000 to its 100% owned subsidiary, Stubben Inc., for $100,000.
“Fake” Gain = $60 Gain = $20
Total Gain = $80
In 20X7
Gain +60
Gain on Sale of Land 60,000Land 60,000
Example 1: Consolidation Entry at 12/31/X5Requirement 1 – consolidation entry:
Parker Stubben
Assets = Liabilities + Equity Assets = Liabilities + Equity
Consolidation Entry at 12/31/X5
Land +60
What happens to the gain?
RE +60 Land +60
RE +60
Retained Earnings 60,000Land 60,000
Example 1: Consolidation Entry at 12/31/X6Requirement 1 – consolidation entry:
Parker Stubben
Assets = Liabilities + Equity Assets = Liabilities + Equity
Consolidation Entry at 12/31/X6 (and all years until land is sold)
Land +60
RE +60
Retained Earnings 60,000Gain on Sale 60,000
Example 1: Consolidation Entry at 12/31/X7Requirement 2 – consolidation entry after land sold:
Parker Stubben
Assets = Liabilities + Equity Assets = Liabilities + Equity
Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7)
Gain +20
What gain should Stubben report in 20X7 when the land is sold?
• Thus, the consolidated gain is $80,000!• What’s the only problem with the partial equity method?
• THE PARENT’S FINANCIAL STATEMENTS ARE NOT CORRECT!
Solution: Parker Company Equity Method Journal Entries
Gain on Sale of Land 60,000Land 60,000
Consolidation Entry at 12/31/X5
Retained Earnings 60,000Land 60,000
Consolidation Entry at 12/31/X6
Retained Earnings 60,000Gain on Sale of Land 60,000
Requirement 1
Requirement 2Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7)
Equity Method Adjustment
NI XXX
Income from SubXXX NI
60,000 Unreal. Gain 60,000
After calculating the unrealized gain, simply make an extra adjustment to back it out.
Do this at the same time you record the parent’s share of the sub’s income.
This ensures that the parent income is
equal to the consolidated
income.
Investment in Sub
Reverse later when the asset is sold!
Example 2: 100% Ownership Land Transfer• On 3/31/X5, Parker Inc. sold land costing $40,000 to its
100% owned subsidiary, Stubben Inc., for $100,000.• Now assume Parker adjusts for this transaction in the
equity accounts.• This is the fully adjusted equity method!• How would your answers change?
Required:1. Prepare the consolidation entry(ies) as of 12/31/X5
and 12/31/X6.2. Prepare the consolidation entry at 12/31/X7,
assuming that Stubben sold the land in 20X7 for $120,000.
Example 2: 100% Ownership Land Transfer
Parker Stubben$40 $120$100
On 3/31/X5, Parker Inc. sold land costing $40,000 to its 100% owned subsidiary, Stubben Inc., for $100,000.
“Fake” Gain = $60 Gain = $20
Total Gain = $80
In 20X7
Investment in Sub Income from Sub
NI XXX XXX NI 60,000 Unreal. 60,000
Gain
This defers the gain until later
ONE EXTRA STEP! Equity Method Adjustment
Gain +60
Gain on Sale of Land 60,000Land 60,000
Example 2: Consolidation Entry at 12/31/X5Requirement 1:
Parker Stubben
Assets = Liabilities + Equity Assets = Liabilities + Equity
Consolidation Entry at 12/31/X5
Land +60
RE correct
Invest 60Income from Sub 60
• The equity method adjustment “fixes” parent’s books!
Same!
What happens to the gain AND Income from Sub?
They cancel out!Invest 60 Land +60
What happens to the equity method accounts?• Eliminated in the consolidation. But we still need to fix the problem!
Investment 60,000Land 60,000
Example 2: Consolidation Entry at 12/31/X6Requirement 1:
Parker Stubben
Assets = Liabilities + Equity Assets = Liabilities + Equity
Consolidation Entry at 12/31/X6 (and all years until land is sold)
Land +60Invest 60
• The normal basic elimination entry will still eliminate BV of equity.• The investment account will be “over eliminated” and left with a 60,000
credit!• We can’t leave a “balance” in that account in the consolidated B/S!
• This entry eliminates the investment account and fixes the land balance.
Investment 60,000Gain on Sale 60,000
Example 2: Consolidation Entry at 12/31/X7Requirement 1:
Parker Stubben
Assets = Liabilities + Equity Assets = Liabilities + Equity
Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7)
Invest 60
What gain should Stubben report in 20X7 when the land is resold?
• Thus, the consolidated gain is $80,000!• We also reverse out the equity method deferral this year.• THE PARENT’S FINANCIAL STATEMENTS ARE ALWAYS CORRECT!
Gain +20
Example 2: Solution Summary
Gain on Sale of Land 60,000Land 60,000
Consolidation Entry at 12/31/X5
Investment in Stubben 60,000Land 60,000
Consolidation Entry at 12/31/X6
Investment in Stubben 60,000Gain on Sale of Land 60,000
Requirement 1
Requirement 2Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7)
Consolidation Worksheet—20X5
Adjustments
Parent Sub DR CRConsol-idated
Income Statement Gain on Sale 60,000 60,000 0
Income from Sub (60,000)Lower Basic 0
Balance Sheet
Investment in Sub (60,000)Lower Basic 0
Land 100,000 60,000 40,000
Consolidation Worksheet—20X6
Adjustments
Parent Sub DR CRConsol-idated
Income Statement
Balance Sheet
Investment in Sub (60,000)Lower
60,000Basic 0
Land 100,000 60,000 40,000
Consolidation Worksheet—20X7
Adjustments
Parent Sub DR CRConsol-idated
Income Statement Gain on Sale 20,000 60,000 80,000
Balance Sheet
Investment in Sub (60,000)Lower
60,000Basic 0
Land 0 0
Learning Objective 3
Prepare equity-method journal entries and elimination entries for the consolidation of a subsidiary
following a downstream land transfer.
Downstream Sale of Land
• Peerless Products purchases 80% of the common stock of Special Foods on Dec 31, 20X0, on its book value of $240,000. The fair value of Special Foods NCI is equal to its nook value of $60,000.• During 20X1, Peerless reports separate income of
$140,000 and declares dividends of $60,000.• Special Foods reports net income of $50,000 and
declares dividend of $30,000.• July 1, 20X1, Peerless sells land to Special Foods for
$35,000, which was purchased on Jan 1, 20X1, for $20,000, resulting an unrealized gain of $15,000. • Special Foods holds the land until the following
years.
P
S
NCI
20%
80%
Fully adjusted equity-method entries – 20X1• 20X1 Peerless records its share of Special Foods’ income and
dividend.
(5) Investment in Special Foods 40,000
Income from Special Foods 40,000
Record Peerless’ 80% share of Special Foods’ 20X1 income
(6) Cash 24,000
Investment in Special Foods 24,000
Record Peerless’ 80% share of Special Foods’ 20X1 dividend
• Under the fully adjusted equity method, Peerless defers the entire $15,000 using the following entry:
• Objectives: (1) Peerless income is overstated by $15,000, the adjustment
to Income from Special Foods offsets this overstatement – Peerless net income is now correct, and
(2) Special Foods’ land account is currently overstated by $15,000 (was recorded for $20,000 but purchased for $35,000), reduction on the investment account offsets the overstatement and defer the unrealized gain.
(7) Income from Special Foods 15,000
Investment in Special Foods 15,000
Defer gain on intercompany land sale to Special Foods
Fully adjusted equity-method entries – 20X1
Basic investment account elimination entry:
Common stock 200,000Retained earnings 100,000Income from Special Foods 25,000NCI in NI of Special Foods 10,000 Dividend declared 30,000 Investment in Special Foods 241,000 NCI in NA of Special Foods 64,000
Consolidation Worksheet—20X1
Adjustments
Parent Sub DR CRConsol-idated
Income Statement Gain on Sale 15,000 15,000 0 Income from Sub 25,000 25,000
Basic 0
Balance Sheet Investment in Sub 241,000 241,000
Basic 0
Land 155,000 75,000 15,000 215,000
Group Exercise 1: Partial Ownership Land Transfer
• Stubben Corporation is a 90%-owned subsidiary of Parker Corporation, acquired for $270,000 on 1/1/X5.
• Investment cost was equal to book value and fair value.• Stubben’s net income in 20X5 was $70,000, and Parker’s
income, excluding its income from Stubben, was $90,000.• Parker’s income includes a $10,000 unrealized gain on land
that cost $40,000 and was sold to Stubben for $50,000. • Assume that Stubben sold the land in 20X7 for $65,000.
Assume Parker adjusts for this transaction in the equity accounts.NOTE: This is a downstream transaction.
Required: 1. What entry(ies) would Parker make in 20X5 and 20X7?2. Prepare the consolidation entries at 12/31/X5, 12/31/X6,
and 12/31/X7.
P
S
NCI
10%
90%
Group Exercise 1: Solution
20X5 Equity Method Entries
Requirement 1
20X7 Equity Method Entry (after Stubben resold the land)
Group Exercise 1: Solution
Consolidation Entry at 12/31/X6
Requirement 2
Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7)
Consolidation Entry at 12/31/X5
Consolidation Worksheet—20X5
Adjustments
Parent Sub DR CRConsol-idated
Income Statement Gain on Sale 10,000 10,000 0
Income from Sub 53,000 53,000Basic 0
Balance Sheet
Investment in Sub 323,000 323,000Basic 0
Land 50,000 10,000 40,000
Consolidation Worksheet—20X6
Adjustments
Parent Sub DR CRConsol-idated
Income Statement
Balance Sheet
Investment in Sub (10,000)Lower 10,000 Basic 0
Land 50,000 10,000 40,000
Learning Objective 4
Prepare equity-method journal entries and elimination entries for the consolidation of a subsidiary
following an upstream land transfer.
Illustration (p. 318 - 321)Peerless Products Corporation acquires land for $20,000 on January 1, 20X1, and sells the land to its subsidiary, Special Food Incorporated, on July 1, 20X1, for $35,000
Peerless Product
SpecialFoods
Jan 1, 20X1Jul 1, 20X1
Purchase land
Inter-corporate transfer of
land
Consolidated Entity
$35 $20
Upstream Sale of Land• Peerless Products purchases 80% of the common
stock of Special Foods on Dec 31, 20X0, on its book value of $240,000. The fair value of Special Foods NCI is equal to its nook value of $60,000.• During 20X1, Peerless reports separate income of
$140,000 and declares dividends of $60,000.• Special Foods reports net income of $50,000 and
declares dividend of $30,000.• July 1, 20X1, Special Foods sells land to Peerless for
$35,000, which was purchased on Jan 1, 20X1, for $20,000, resulting an unrealized gain of $15,000. • Special Foods holds the land until the following
years.
P
S
NCI
20%
80%
• 20X1 Peerless records its share of Special Foods’ income and dividend under the fully adjusted method:
(8) Investment in Special Foods 40,000
Income from Special Foods 40,000
Record Peerless’ 80% share of Special Foods’ 20X1 income
(9) Cash 24,000
Investment in Special Foods 24,000
Record Peerless’ 80% share of Special Foods’ 20X1 dividend
Fully adjusted equity-method entries – 20X1• Under the fully adjusted equity method, Peerless Inc. defers
relative share of the unrealized gross profit is $12,000 (15,000 X 0.80)
Until resold to external party by Special Food, the carrying value of land must be reduces each time consolidated statements are prepared
(10) Income from special Foods 12,000
Investment in Special Foods 12,000
Defer gain on intercompany land sale to Special Foods.
Basic investment account elimination entry:
Common stock 200,000Retained earnings 100,000Income from Special Foods 40,000NCI in NI of Special Foods 10,000 Dividend declared 30,000 Investment in Special Foods 256,000 NCI in NA of Special Foods 64,000
Partially Owned Upstream Sales Equity Method Adjustment• Similar to what we did with inventory
transfers: we must share deferral with the NCI shareholders• Simply split up the adjustment for unrealized
gains proportionately.
Unreal. 3,000 Gain To NCI Shareholders
P
S
NCI
20%
80%Equity MethodAdjustments
Investment in Special Foods
12,000
Income from Special Foods
12,000Unreal. GainNI 52,000 52,000 NI
40,000
Group Exercise 2: Partial Ownership Land Transfer• Stubben Corporation is a 90%-owned subsidiary of Parker
Corporation, acquired for $270,000 on 1/1/X5.• Investment cost was equal to book value and fair value.• Stubben’s net income in 20X5 was $70,000, and Parker’s
income, excluding its income from Stubben, was $90,000.• Stubben’s income includes a $10,000 unrealized gain on land
that cost $40,000 and was sold to Parker for $50,000.• Assume that Parker sold the land in 20X7 for $65,000.• Assume Parker adjusts for this transaction in the equity
accounts.• Assume that Stubben sold the land in 20X7 for $65,000.• Assume Parker adjusts for this transaction in the equity
accounts.Required: 1. What entry(ies) would Parker make in 20X5 and 20X7?2. Prepare the consolidation entries at 12/31/X5, 12/31/X6,
and 12/31/X7.
P
S
NCI
10%
90%
Partially Owned Upstream Sales Equity Method Adjustment• Similar to what we did with inventory
transfers: we must share deferral with the NCI shareholders• Simply split up the adjustment for unrealized
gains proportionately.
Unreal. 1,000 Gain To NCI Shareholders
P
S
NCI
10%
90%Equity MethodAdjustments
Investment in Stubben
9,000
Income from Stubben
9,000Unreal. GainNI 63,000 63,000 NI
54,000
Solution: Parker Company Equity Method Journal Entries
20X5 Equity Method Entries
Requirement 1
20X7 Equity Method Entry (after Stubben resold the land)
Solution: Parker Company Equity Method Journal Entries
Consolidation Entry at 12/31/X5
Consolidation Entry at 12/31/X6
Requirement 2
Requirement 3Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7)
Consolidation Worksheet—20X5
Adjustments
Parent Sub DR CRConsol-idated
Income Statement Gain on Sale 10,000 10,000 0
Income from Sub 54,000 54,000Basic 0
Balance Sheet
Investment in Sub 324,000 324,000Basic 0
Land 50,000 10,000 40,000
Consolidation Worksheet—20X6
Adjustments
Parent Sub DR CRConsol-idated
Income Statement Income from Sub Basic 0Balance Sheet
Investment in Sub (9,000)Lower
9,000Basic 0
NCI in NA 1,000 1,000Lower
Land 50,000 10,000 40,000
Consolidation Worksheet—20X7
Adjustments
Parent Sub DR CRConsol-idated
Income Statement Gain on Sale 15,000 10,000 25,000 Income from Sub Basic 0Balance Sheet
Investment in Sub (9,000)Lower
9,000Basic 0
NCI in NA 1,000 1,000Lower
Land 0